Most investors try to buy low and sell high. But it’s also possible to profit from falling stock prices. A long put is an option strategy that gives you the opportunity to make money when an investment price declines. Here are the potential benefits and risks of a long-put strategy, and how to trade long puts.
What is a long put?
A long-put strategy means you buy a put option: a type of option contract that gives the buyer the right, but not the obligation, to sell a stock or exchange-traded fund (ETF) at a predetermined price (known as the strike price) up until the contract expires (i.e., the expiration date).
Put option buyers have a bearish outlook on an underlying investment—which can be a stock or ETF. This means they think its price will decline over the lifetime of the contract.
Commonly, a put buyer will buy a put with a strike price below a stock’s current market price, hoping that their outlook is correct and the stock falls below the strike price before the contract expires. If this happens, there are a couple of potential strategies for the put buyer.
For example, they could sell the put contract before the expiration if the option has increased in value due to the stock price decline. Or, the put buyer could also exercise the option, buy those shares at the market price, and then sell them at the higher price that’s guaranteed by their options contract.
What if the stock price doesn’t move in the direction that you anticipated? If the stock price does not fall below the put option strike price, then the contract will expire worthless, and the put buyer loses the money they spent to buy the option. The good news is that’s the maximum potential loss with a long put, so risk is defined in advance of the trade.
How does a long put work?
Most option contracts cover 100 shares of the underlying stock. The option cost, known as the premium, gives the buyer the right to sell 100 shares—but you’re under no obligation to do so.
When buying a long put, you select a strike price and expiration date in the option chain: A set of detailed, real-time quotes for an underlying security or index, and the associated calls and puts. You choose your put based on how much you think the stock’s price will decline and when you expect that to happen—among other factors.
After buying the put, it’s critical to monitor the underlying stock price.
If your outlook is wrong and the stock price doesn’t fall during the lifetime of the contract, then your contract may begin to lose significant value, especially if the trade is nearing the expiration date. In that case, you can close the contract or just let it expire. If the price of the underlying asset remains neutral or increases by the expiration date, your contract will expire worthless, and you’ll be out your options premium.
Alternatively, if the stock’s value falls below your strike price at any time up until the expiration date, you can exercise it. Your profit will be the difference between the market price when you exercise and your strike price—minus the premium, the amount you spent to buy the option. That’s a key point to remember, because you won’t start earning profits until you’ve covered your premium costs, which is known as your breakeven point.
If there was a major price decline before an option contract expires, the value of the long put contract would rise. In that case, a trader might choose to simply sell their put option in the open market before the contract expires. That’s because it would help them lock in the profits.
Keep in mind that a small price movement or no movement at all is a more likely scenario than a major price decline. And by entering a put option, you are risking that option premium for the chance to profit off a decline.
Long put vs. short put
A long put and a short put are opposite sides of an option trade. A long put gives you the right to sell shares of a stock at a specific price within a certain period, and the person selling the put agrees to buy those shares from you.
Selling a put is also known as a short put. Someone using a short-put strategy is typically neutral to bullish on the stock. They think its price will increase in the near future, or at least stay relatively flat, giving them the potential opportunity to buy those shares at a price below current market value. The put seller also earns a premium for taking on that obligation.
Example of a long put
Let’s say ABC stock is currently trading at $45. Next month, the company is announcing earnings and you think the results are likely to fall short of expectations and the stock price will decline. After examining the options chain for ABC, you decide to buy a long-put contract that covers 100 shares of ABC with a strike price of $42, paying a premium of $2 per share, and an expiration date in 30 days. Your cost for buying the put is $200 (100 shares x $2 premium).
In this example, the breakeven point is $40 for the lifetime of the contract, which is your $42 strike price minus the $2 per share premium. That breakeven point is the same if you hold your put option through its expiration, or if you trade that option and exit the position before the expiration. That means you would start making a profit when the stock falls below $40.
Let’s say, for example, ABC shares remain around $45 or increase throughout the lifetime of your contract. In this scenario, you would lose your option premium of $200 and would make no profit. In fact, even if ABC falls slightly in price to $42.50 for example, you would still be out your options premium as the option is still “out of the money” and the share price has not crossed the strike price. Even if ABC falls below the strike price to $41 and the option is in the money, you still won’t make a profit, as you haven’t passed the breakeven point.
Alternatively, if ABC shares drop to $39, the contract is in the money by $1 per share, or $100. But you haven’t locked in any profits until you exercise or sell the option—these are unrealized gains. Your potential profits will increase the further the market price falls below your breakeven price, and in the rarest of cases you could theoretically earn as much as $4,000 (less the $200 cost) in profit if the ABC stock drops to $0 before the expiration date. Of course, a stock falling to $0 is unlikely.
Say ABC shares fall to $35. You exercise your contract to sell 100 shares at the $42 strike price, purchase shares for $3,500 on the market, and receive $4,200 for selling them. After deducting your $2 per share premium, you’ve made a profit of $5 per share, or $500, on a single contract. That’s a 150% return on your $200 investment.
Benefits of long puts
1. You could profit from a falling stock price. When you have a bearish outlook on a stock, a long put gives you the right to sell those shares above market value if your outlook is correct.
2. You could enhance returns by putting up less cash. Because you only pay a premium to buy a long put (plus any brokerage fees or commissions), long puts offer the chance to profit on less investment outlay compared with shorting the stock, the process of selling “borrowed” stock at the current price, then closing the deal by purchasing the stock at a future time.
3. Your losses are limited. You can only lose your premium, no matter how high the stock price rises during the contract’s lifetime.
Risks of long puts
1. You could lose your premium. You pay your premium up front and risk losing that premium if the underlying stock price doesn’t fall, and you may not recoup your entire premium if the price of the underlying stock doesn’t fall beyond your breakeven point.
2. Trading against historic trends. Over the long term historically, stocks have had a propensity to increase in value over time, though past performance doesn’t guarantee future results. By entering a short position with a long put, you are only profiting from a decrease in price. If the price of the underlying asset remains neutral or increases in value, you will lose your premium and not profit.
How to buy long puts
If you’re interested in a long-put strategy, these steps can help you get started.
1. Open and fund a brokerage account.
Trading options requires a brokerage account. If you don’t already have an account, look for one with low fees and helpful research tools. You also need to transfer money into that account to pay for any long-put premiums.
2. Apply to trade options, if necessary.
Some brokerages require you to apply to trade options. At Fidelity, this involves completing an application about your finances and your investing experience.
3. Research investment options and start buying long puts.
If you don’t already have an outlook on a particular stock or ETF, you can use your brokerage’s resources to research companies and identify stocks you expect to decline in price. To find options contracts on that stock, log into your brokerage account, access the option chain, and enter the ticker symbol. The option chain potentially lets you view several strike prices, expiration dates, and quotes of the options. You also can trade right from the option chain. If you trade at Fidelity, we have an Option Strategy Builder to help you build and place an option trade and apply a strategy for your objective.